Study 9 – The Insurance Contract

Insurance contracts have three additional requirements to become legally binding contracts;

• Insurable interest – you must have a financial interest in the property.  Examples include:

Property – owners, lessees, tenants, custodians

Liability – if you can be held legally liable of injury or damage caused to others.

Life and Health – of immediate family or persons you are financially dependent on.

• Indemnity – to place someone back on the same financial position they were immediately prior to the loss. Insured’s may not collect more or less than the extent of their financial loss and the amount is subject to policy conditions such as, deductibles and limits. Actual Cash Value is the value of an equivalent item of the same age and condition. Certain insurance contract contradict this principle:

Contracts of compensation – have a stated amount payable e.g. life insurance.

Valued Contracts – the value is determined at the time of insurance e.g. jewellery, art.

Replacement cost contracts – the value will be based on the cost to repair or replace whichever is less, there is no deduction for depreciation. These contracts are priced differently than ACV.

• Utmost Good Faith – means the onus to disclose material facts is heaviest on the insured. A material fact is one that affects the acceptance or cost of insurance. Failing to disclose a material fact is misrepresentation or non-disclosure (concealment).

Non disclosure is defined as silence when there is an obligation to speak.  The insurer must prove the non-disclosure in court. A contract can be voidable if obtained by a misrepresentation.

Provincial legislation (or the Civil Code in Quebec) sets out the good faith requirements. Insurance contracts are required by law to carry certain statutory conditions that define the extent of utmost good faith required from an insured.

All material facts must be disclosed upon application for insurance. New material facts must be reported promptly to an insurer.

When the broker does not have binding authority, insurer may regard any omission as failure to disclose and void the contract with the insured. If the insured informed the broker and the broker failed to pass the information along, the insured may initiate legal action against the broker.

When a broker does have binding authority, if the broker knew the information then it is considered that the insurer knew the information and the insured may still collect under the contract. The insurer may then take action against the broker for violating the broker agreement.

Insurers utmost good faith includes remaining solvent and dealing with claims fairly and promptly.

Sample Exam Questions – Principles & Practices

December 2001

1. Insurable interest is the
1. interest a life insurance company pays on certain types of policies.
2. Interest an insurance company earns on its investments.
3. Interest an underwriter has in writing a profitable line of business.
4. Monetary interest a person might have in the happening of a loss.

2. The actual cash value of an article can be defined as its
1. fair value
2. market value
3. replacement value
4. salvage value

3. A contract of compensation
1. is the equivalent of a contract of indemnity
2. states that a preset amount is payable when an event occurs.
3. States that an amount is predicated on the values at the time of loss.
4. States that an employer must pay a specific amount when an employee is injured.

4. A valued insurance contract is one
1. That is, in effect, a replacement cost contract
2. That is valued by the broker and the insurer because of the very large premium produced.
3. That is values by the insured because the risk was extremely difficult to place.
4. Under which, in the event of a loss a definite amount will be paid.

5. Utmost good faith
1. Can void an insurance policy
2. Implies a high standard of honesty
3. Is a mythical faith in the goodness of people
4. A requirement of all legal contracts.

July 2001

6. Insurable interest is the
1. interest an insurer earns on its investments
2. interest an insurer has in earning underwriting profit
3. interest an insurer has in increasing the size of its portfolio of business.
4. Monetary interest an insured has in the occurrence or non occurrence of a loss.

7. The actual cash value of an item of property that has been lost or destroyed can be best described as the
1. original purchase price of the item
2. replacement cost of the item at the time of loss
3. value of the item to the insured at the time of loss
4. value of the equivalent item of the same age and condition

8. A valued insurance contract
1. implies that, because of the higher premium the contract is a valued one.
2. Implies that the amount to be paid in the event of a loss is determined when the policy is written.
3. Is a life insurance policy under which an agreed amount will be paid on the death of the insured.
4. Is a replacement cost contract

April 2001

9. Which of the following is a true statement?
1. Losses that occurred before a policy was declared void must be paid.
2. Non-disclosure is a form of misrepresentation
3. To void a policy is the same as terminating it
4. When an insurer terminates a policy, the return premium is calculated on a short rate basis.

10. Persons who stand in such a legal relationship to property that they may be financially prejudiced by its loss and may financially gain by its continued existence are said to have
1. a right of subrogation in the property
2. insurable interest in the property
3. legal capacity in the property
4. legal liability in the property

11. When someone is placed back in the same financial position that they were just rpior to a loss, that is
1. actual cash value
2. consideration
3. contribution
4. indemnity

12. The agreed value of property insured on a valued basis
1. an amount of insurance that corresponds to the appraisal value of the property
2. the actual cash value of the property
3. the actual cash value of the property plus appreciation
4. the value of a property agreed to after a loss.

13. Utmost good faith
1. can void an insurance policy
2. implies a high standard of honesty
3. is a mythical faith in the goodness of people
4. is a requirement of all legal contracts

December 2000

1. Which of the following statements is NOT true? For an insurance policy to be legally issued, the law requires that

1. it be done in utmost good faith
2. there be a promise of indemnity
3. there be a risk involved
4. there be an eventual insurable interest

2. A contract of compensation states that
1. a preset amount is payable when a loss occurs
2. an amount is predicted on the values at the time of loss
3. it is the equivalent of a contract of indemnity
4. an employer must pay a specific amount when a employee is injured.

3. The principle of indemnity provides that
1. Life insurance can not be written on children unless they are working.
2. One cannot make a profit from one’s insurance policy.
3. The insurance intermediary must be paid a fair commission for his work.
4. Those responsible for an accident must indemnify the person(s) injured.

4. Actual Cash Value refers to replacing a lost or damaged article with a similar article
1. based on the original price
2. in the same condition
3. without deduction for depreciation
4. (a) and (c)

July 2000

14. A person has applied for fire insurance on their house, but has failed to mention that during the winter months they service and store lawnmowers in their garage and basement. This would be an example of:
1. An innocent misrepresentation
2. A fraudulent misrepresentation
3. A non-disclosure
4. A breach of warranty

April 2000

15. A valued contract of insurance
1. produces a very large premium
2. pays a predetermined amount in the event of loss
3. insures items of a very high value
4. is strictly a contract of compensation.

16. Indemnification can best be described as being the
1. spread of risk
2. restitution of financial loss
3. elimination of risk
4. reduction of the consequences of financial loss.

17. The actual cash value of a lady’s dress which has been damaged in a fire can best be described   as being the:
1. cost price of the dress
2. cost of replacing the dress
3. value of an equivalent dress of the same material, age, condition and fashion as the damaged dress.
4. Sale price of the dress

Essay Questions

December 2001

1. Contrast a valued contract with a replacement cost contract   (5 marks)

December 2000

2. (a) Contract a Contract of Indemnity with a Contract of Compensation   (4 marks)

(b) Contrast a Valued Contract with a Replacement Cost Contract    (4 marks)

July 2000

© Explain the differences between the following terms, using examples to illustrate your answers       (6 marks)

3. (a) Describe the following principles and explain why they are important elements of an insurance contract        

i) insurable interest        (5 marks)

ii) Indemnity        (5 marks)

iii) Utmost good faith        (5 marks)